As politicians and pundits debate the merits of a carbon trading system, business leaders are gearing up for what they believe will be the creation of one of the largest new industries in decades — and Houston, experts say, is poised to play a key role in the new market.

“It is a very major deal,” says Praveen Kumar, chair of the department of finance and executive director of the Global Energy Management Institute at the University of Houston. “You are commoditizing what is involved in the production of large sectors of most modern economies.”

The Basics

Carbon trading is the exchange of credits, either auctioned or distributed freely by a governing body, that allow companies to emit a set quantity of carbon — measured in tons — into the atmosphere. Commonly referred to as a cap-and-trade system, under this scheme, companies are given a maximum amount, or cap, of carbon they can emit through their allotment of credits. Those who exceed the cap are fined.

Companies can, however, purchase unused credits from other companies on an exchange if they require more.

If the system works properly, emitting excess carbon into the atmosphere becomes prohibitively expensive, as the biggest emitters would have to purchase more credits than they are supplied. This makes investments in cleaner, more efficient manufacturing methods or power generation a cheaper alternative.

Washington has been mulling over national cap-and-trade legislation for several years now, but with the ascendancy of the Obama administration, most analysts say that carbon regulation in the near future is likely.

Several congressional bills are in various stages, with the most developed being introduced by Rep. Henry Waxman (D-Calif.) and Rep. Edward Markey (D-Mass.).

A politically charged subject, carbon trading’s impact on the economy has been the subject of most opponents’ criticisms. Placing carbon emissions restrictions will raise the prices of energy and manufactured goods and may drive industries to unregulated countries, they say.

Local impact

Controversy aside, most experts say some form of carbon regulation is coming, and Houston, with its prominent place in the energy industry, stands to become a hub for carbon trading.

“In Houston, we bill ourselves as the ‘energy capital of the world,’ ” says Ben Cowan, partner at law firm Locke Lord Bissell & Liddell LLP and head of its climate change practice team. “We have a number of domestic and international energy companies that will be impacted by any cap-and-trade system that will be implemented.”

Large energy companies like Reliant Energy Inc., Shell Oil Co. and CenterPoint Energy Inc. call Houston home. Many other major companies, as well as the law firms that service them, have been interested in carbon trading expertise for some time now, says Tracy Hester, a partner at Bracewell & Giuliani LLP and head of the firm’s environmental law section in Houston.

“I see practices already being reshaped by climate trading,” Hester says. “In the future, you may see carbon trading as an integral part of a project’s package. You may need to have carbon credits locked up to develop a large power project, for example.”

But Hester says it is too early to know if law firms will have dedicated carbon trading practice groups.

Preparations

Several Houston companies aren’t waiting on the sidelines for the industry to come to the city; they are actively trying to promote it.

Cowan and the Greater Houston Partnership’s Carbon Trading Task Force have put together the Houston Climate Alliance, a nonprofit organization comprised of Houston companies in the energy trading and alternative energy industries.

The city is widely considered a hub for conventional energy trading markets, and Cowan says HCA seeks to make it known that the infrastructure already here can extend that hub to the burgeoning carbon trading industry.

“The Houston Climate Alliance is an effort to recognize that Houston is really the natural location for the carbon trading industry, given the intellectual capital that is already here as well as the presence of key companies,” Cowan says.

But that won’t come without significant advancement in the legal and regulatory framework for cap-and-trade, says Kumar.

“One issue is going to be manipulation,” Kumar says. “Because this is going to be a commodities market, there are all kinds of possibilities for aggressive money to move in and try to manipulate things.”

Kumar and his colleagues have spoken with state and national officials from across the country about cap-and-trade legislation. In speaking with California state government officials, Kumar says they expressed concern over market manipulation because of the state’s experience during their 2000-2001 utilities crisis, in which Northern California suffered high electricity prices and rolling blackouts.

“You have to set up a legal framework to deter this,” Kumar says.

Moreover, if a system were to include the trading of carbon offsets, regulations must be put into place to ensure the efficiency of the offset project.

Carbon offsets are similar to credits, but instead of a government-allocated amount of carbon emissions being traded, funding for individual projects that counter global warming, such as reforestation initiatives, is traded on an exchange.

“Say, for example, a developer draws up a project,” Kumar says. “The project is accepted (by a governing body) and is sold as an offset. But once a company buys it, who is responsible for the project’s performance? What if the developer goes bankrupt? You will see an incentive among some to take the money and run.”

These issues have yet to be sorted out at either a state or national level, Kumar says. And without clear policies guiding the industry it isn’t likely to succeed.

‘Cap and Trade’ 101

That’s why Kumar, along with several colleagues at the University of Houston’s Bauer College of Business and UH’s Law Center, have put together a graduate-level program — the first of its kind in the nation — designed to introduce students to the challenges associated with establishing a carbon trading industry. The program has recently wrapped up its first semester.

“What we wanted to do was give us a head start in understanding all aspects of this emerging market,” Kumar says. “You are creating a new kind of commodity and there are some very important legal aspects to be created.”

Students study existing carbon exchanges around the globe and analyze case studies, drawing up their own policy proposals.

“It’s not just a course though,” Kumar says. “We are building up to start actual research projects where we bring in expertise in legal and market design to create a regulatory framework.”

That intellectual capital is what will help grow the carbon trading industry here in Houston, Kumar says.

“Houston needs the bulk of the analysis and the deals to get done here,” Kumar says. “We need the analytical ability to evaluate these assets. We need that brain center here.”

New York is not the financial center because the New York Stock Exchange is located there anymore, Kumar says. Modern communications allow people to make trades from anywhere. New York remains the nation’s financial capital because of the human capital residing there.

“They have the analysts; they create the trading strategies,” Kumar says.

Kumar’s vision may be turning out to be a reality. In the final days of the semester, Kumar says, two students went before the class to announce they were starting their own carbon trading consulting businesses.

“They were looking to hire people, they told them to send them their resumés if they were interested,” Kumar says.

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